Herbert Smith

Energy law in the Republic of Kazakhstan

Recent developments in the energy market in the Republic of Kazakhstan

By Yuliya Daurova, LLM, partner of Linkage & Mind, Kazakhstan

Oil and gas, mining, electricity, transport and communications and chemicals and pharmaceuticals are key industrial sectors in Kazakhstan. These sectors were included in the State Programme for Accelerated Industrial-Innovative Development (2010-2014) (the "Programme") as high priority sectors for development.

The Programme aims to diversify the economy and modernise existing industries. In 2011 , Samruk-Kazyna a national welfare fund) is undertaking 20 projects at a

combined cost of US$22 billion which represents around

51% of the total funds available under the programme.

US$6.8 billion is to be invested into the energy sector.

n the electricity sector, power generation is designated as a vital industry. Thus, the Programme includes ~e modernisation of existing power plants and the 'ltroduction of new ones.

Samruk-Kazyna has many subsidiary

companies, including:

• Samruk-Energo which holds stakes in thermal and hydroelectric plants and

distribution companies;

• Kazakhstan Electricity Grid Operating Company (KEGOC), the national electricity grid operator;

KazMunaiGas, a national company; and

• Kazatomprom, a nuclear company.

~.,e global economic crisis has dealt a heavy blow to

=:::anomie growth in Kazakhstan. However, measures ·-at were adopted to counter the crisis have been largely

::~ccessful. These measures included an injection of _S$19 billion by way of economic stimulus from NFW

:::amruk-Kazyna and other measures taken by the .a ional Bank. Kazakhstan was one of the first countries

·:: emerge from the global economic crisis and recorded ~~d economic growth of 7% in 2010.

::: .Jrrently 41% of the country's thermal power plants ~-d 68% of its hydroelectric power plants have been in

- the European Energy Handbook 2012

service for over thirty years. A number of projects have recently been started under the afore-mentioned state programme. These include:

• Modernisation of the country's electricity network

and construction of the second 500kV electricity line from the North to the South of Kazakhstan which are being undertaken by KEGOC;

• Construction of a regional power station in the Third Energy block at Ekibastuz;

• Construction of Moinak Hydro-Electric Power w ith a

projected total cost of the US$340 million;

• Construction of the second 500kV power line from North to South with total projected costs of US$295 million;

• Construction of an interregional power line in Aktobe region in Northern Kazakhstan with a projected total cost of US$165 million;

• Construction of a thermal power plant at Balkhash at a total cost of US$4.7 billion;

• An international project involving the construction of new power lines from Kemin to Almaty with total

investments amounting to US$140 million;

• Kazatomprom started building a solar panel plant at Astana in March 2011. The cost of the project is around US$230 million;

• Asia Green Power, a joint venture between Italy and Turkey consisting of an agreement to build two wind farms in order to reduce power shortages in the south of the country. The project is valued at US$1 billion;

• Construction of an integrated chemicals complex in the Atyrau region. The operator of the project is

Kazakhstan Petrochemical Industries Inc (KPI); and

• The opening of the Central Asia to China gas pipeline, which runs through Kazakhstan, has been

a major development in recent years. It is hoped the development of the new Caspian gas pipeline will have a similar effect although its progress has been delayed due to ongoing negotiations with Russia and Turkmenistan.

217

::0 (1) "C c: C"

:a CD "C c C'" --· (')

0 ......

" D.) N D.) ~ ::T Ul r+ D.) :::l

In addition a number of deals have recently been concluded with the aim of enhancing national energy

security by increasing production capacities and improving the quality of services:

• In 2011 , JSC Kazmunaigas (National

Company) , a state-owned company purchased Aktaunefteservis LLP;

• In 2011 , Kazatomprom (a national holdings company) and Chemieanlagenbau Chemnitz GmbH (a German company) entered into a Memorandum of Co-operation;

• In 2011 , Tethys Petroleum Limited announced the signing of a joint venture agreement between two of

its subsidiaries, Tetismuanygas and Eurasia Gas LLP;

• In 2009, Kazakhmys Pic purchased 10% of the share capital of Balkhashskaya Thermal Power Plant;

• In 2009, NWF Samruk-Kazyna purchased 50% of the share capital of the electric power plant GRES- 1 Ekibastuz; and

• In 2009, Mangistau Investments B.V. purchased 100% of the share capital of JSC Mangistaumunaigas.

Given the old age of many of the power plants in Kazakhstan , deterioration of plant equipment is a real issue that creates electricity shortages. This can even threaten the stable economic development of the

country. Therefore, the power industry has to solve this problem. The market must operate in such a way as to ensure that the power supply companies (who, effectively, are investors) are guaranteed a return on the cost of commissioning new equipment and/or the cost of maintaining existing power stations. Electricity companies will sell power on the power market

to KEGOC, while electricity will be freely traded at

competitive prices.

The main law regulating the electric energy industry is the law On Electricity dated 9 July 2004. Under the terms

of Article 9 of the Law, engineering and construction of standby (shunting) power lines and substations may only be performed with preliminary notification and

coordination with:

• The Committee for State supervision and control over energy;

• The Agency of the Republic of Kazakhstan for Regulation of Natural Monopolies (AREM); and

• KEGOC (the system operator).

Projecting and construction of power stations, power

lines and substations as well as their operation may be performed on the basis of concession agreements. According to the Law on Licensing dated 11 January 2007, production, transmission and distribution of

electricity and operation of power stations, power grids and sub-stations are subject to licensing.

The main law regulating relations among oil and gas

market participants is the Law of the Republic of Kazakhstan No 291-IV On Subsoil and Subsoil Use dated 24 June 2010 ("the New Subsoil Law").

218

Under the New Subsoil Law, rights to use the subsoil arise from:

• a right from the State obtained upon conclusion of an agreement on exploration and/ or extraction of hydrocarbons (like oil and gas);

• transfer of rights to use the subsoil by the previous user. This can either be done explicitly or through the disposal of shares in a legal entity which holds rights to use the subsoil; and

• transfer of rights by all-party agreement in the event

of a legal entity which holds rights to use the subsoil being reorganised.

Exploration contracts can be granted for a period of up to six years. Thereafter they may be extended twice for a period of up to two years each. After a commercial

discovery is made, the subsoil user has the exclusive right to negotiate an extraction contract. Extraction contracts

can be granted for up to 25 years or up to 45 years in a case where the recoverable reserves consist of more than 100 billion cubic meters of natural gas.

Almost all types of subsoil use activity are carried out for a limited period of time and the above contracts are subject to a fee.

In accordance with the New Subsoil Law, subsoil model contracts contain local content, including a requirement

to hire Kazakhstani personnel and to use goods, services and works of Kazakhstani origin. Those subscribing to model contracts for subsoil use also take on duties which, amongst others, include social responsibility, commencement and rate of subsoil operations, amount of subscription bonus, size of investment, compliance with health, safety and environment requirements under

domestic legislation etc.

The State has pre emptive and priority rights in relation to all natural gas deposits. Where a new party is seeking to enter the market, either by way of purchasing shares

in a company that already has subsoil rights or by way of a transfer of rights, the State has a priority right to acquire the relevant rights (or any part thereof) through a number of different entities unless the acquiring entity has the relevant state approval. Approval to acquire rights must be sought from the Ministry of Oil and Gas. This procedure takes around 70 days.

AREM will subject new market entrants to further requirements and approval processes if the transition

would be such as to create either a monopoly or give a

strategic advantage to the new entity. AREM's consent is required to conclude transactions that would have such an effect. AREM's approval is also required for all transactions where the total book value of assets of the target or the purchaser exceeds 2,000,000 MCI' for the last financial year. Approval from AREM is also required if one of the persons participating in the transaction is a

company holding a dominant or monopolistic position

in the relevant product market. The conclusion of such transactions without prior state approval can lead to nullity of the contract ab initio.

EER- the European Energy Handbook 2012

Currently, the Ministry of Oil and Gas is working on the

development of a Law On Gas and Gas supply. The draft law envisages the establishment of a national operator

for the gas industry which will have the exclusive right

to purchase gas from the gas mining companies of Kazakhstan. There is a pressing need for the new law

in order to ensure efficient modernisation of the current

gas infrastructure in the country. At present the country's gas pipelines, which used to be an integral part of the

USSR single-union system, mainly serve the transit flow of natural gas from Central Asia to the European part of

Russia, Ukraine and the Transcaucasian states. There is

no connection between the major gas pipelines meaning that some regions of the country are gas islands. This

especially affects the western, southern and northern regions of the country.

footnote

1. MCI is the minimum calculation index which is set by the Law on State budget annually. In 2011 it is 1,512 KZT.

EER- the European Energy Handbook 2012 219

Overview of the legal and regulatory framework in the Republic of Kazakhstan

The Republic of Kazakhstan's key industrial sectors are oil and gas, transport and communications, electricity, mining and chemicals and pharmaceuticals. Kazakhstan's State Programme for Accelerated Industrial-Innovative Development 2010 - 2014 (the

"Programme") , the aim of which is to diversify the state's economy and modernise its existing industries,

emphasises these sectors as high priorities for development. Samruk-Kazyna, a major state-controlled joint stock company with diversified interests in Kazakhstan and abroad, carried out 20 projects in 2011

alone under the Programme, at a combined cost of US$22 billion. US$6.8 billion out of US$22 billion have been earmarked for investment into the energy sector.

A. Electricity

A.1 Industry structure

Within the electrical sector emphasis has been placed on power generation, and the Programme provides

for the modernisation of existing power plants as well as the introduction of new ones. Samruk-Kazyna holds extensive domestic assets in the energy sector, including Samruk-Energo (which holds stakes in thermal and hydropower plants and distribution companies),

Kazakhstan Electricity Grid Operating Company ("KEGOC") (which operates the national power grid),

KazMunaiGas (a national gas company) ("KMG") and Kazatomprom (a national nuclear company). The electricity industry was privatised after Kazakhstan gained its independence in 1991, and in addition to these

major state-backed players there are numerous private power production and distribution companies.

According to KEGOC's annual report, electricity in

Kazakhstan is produced by 66 power plants. Thermal plants account for 85.5% of the country's power generation, with the remaining power produced by hydroelectric (8.8%) and gas turbine stations (5.7%).

The main law regulating the sector is law No 588-11 On Electricity, dated 9 July 20041 (the "Electricity Law"), which regulates relations between electricity

production companies and the market. Since June 2010 the electrical sector's main regulator has been the Committee of State Supervision and Control over Energy, within the Ministry of Industry and New Technologies ("the Committee").

Under Article 9 of the Electricity Law, projection and

construction of standby transmission lines (shunting) and substations may be performed only with preliminary notification to and coordination with the Committee, the system operator (KEGOC) and the Agency of the Republic of Kazakhstan for the Regulation of Natural

220

Monopolies ("AREM"). Projection and construction of power stations, power lines and substations, as well as operation of the same, may be performed on the basis of agreed concessions.

Interregional and interstate electric power lines, substations and distributing installations with a voltage

of 220kV or more which are built on the basis of agreed concessions are, for the period of their operation, for the temporary possession of and use by the concessionaire. The centra!ised operative-dispatcher control of such concessions, as well as their operation , are performed by the system operator on the basis of agreements

made. Upon the end of the concession term, the concessions are transferred to the national power grid.

Law No 214- 111 On Licensing, dated 11 January 20072

(the "Licensing Law"), stipulates that the production, transmission and distribution of electric and thermal power and the operation of power stations, electricity grids and sub-stations shall be subject to licensing by the relevant licensor, in this instance the Committee.

Specific activities subject to Licensing under the Licensing Law include (but are not limited to):

• the production of electricity from sources with a voltage of 35kV or more;

• the transmission and distribution of electricity to consumers;

• the operation of power stations, electrical substations and grids of all types used at hazardous production facilities, except those used for municipal and domestic purposes and for objects of power

used in a single process;

• the production of thermal energy for heating settlements, industrial buildings and facilities, except for the production of heat by the same for their own use;

• the projection, manufacture, assembly or repair of chemical, drilling, petroleum and gas producing, geological prospecting, mining, metallurgical, power, or explosion-protected electric technical

equipment or lifting facilities, as well as boilers with a

working pressure of over 0.7kg/cm2 and heat carrier temperature over 115°C and vessels and pipelines

operating under a pressure of over 0.7kg/cm2, except for the projection, manufacture, assembly or repair of equipment used in common technological processes;

• the purchase of electricity for resale purposes; and

• project survey activities and electricity supply

schemes of inhabited localities including the placement of items for production and the

transportation of electricity in the building system, as well as electricity supply to industrial complexes to be situated in territories between inhabited localities.

EER- the European Energy Handbook 2012

The relevant licence and, if necessary, a supplement to that licence will be issued by the licensor (in this case the Committee) no later than 30 business days (1 0 in the case of small business entities) of an application

being made.

A.2 Electricity trading

KEGOC guarantees market participants access conditions to a power supply, and consumers have a right to choose their electricity supplier. KEGOC, as the system operator, ensures reliable operation of the united

power system of the state and provides system services to enable power transmission and dispatch services in balancing production and consumption. Tariffs for KEGOC as the monopoly holder are regulated by AREM, which sets the uniform tariff (described below) for electricity transmission services through KEGOC for all types of consumers.

Tariffing

Power generation companies may apply an electricity tariff not exceeding the maximum stipulated specifically for them. This maximum can be (1 ) a unified, (2) a calculated or (3) an individual tariff. Exemptions from this ru le include the realisation of a spot bid (for no more than 10% of the generated electricity) in the balancing market and the sale of electricity for export.

Companies are divided into 13 groups for the purposes of the unified tariff. A maximum tariff shall be approved for a group of companies for a period of not less than 7 years but may be adjusted annually, if the need for investment incentivisation arises or if the industry requires it. Under the Government's Order No 392, dated 25 March 2009, the tariff limits vary from 3.3 to 7.7KZT/KWh for 2011. KEGOC's tariff for 2010-2011 is 0.94KZT/KWh.

The calculated tariff is that determined in a feasibility study for a given investment project, and the individual tariff is the calculated tariff as adjusted during implementation of an investment project, which is to be agreed with AREM . Power generation companies have

to conclude model investment contracts3 under rticle 12.3 of the Electricity Law with authorised state bodies in case they are involved in the creation of new assets, or the expansion, renovation, maintenance, reconstruction or modernisation of existing assets.

The final consumers' tariff charged by suppliers depends

on the relevant consumer's type of use (ie whether individual or commercial), the volume of use, and the time and usage of electrical appliances.

Power markets

Power supply in Kazakhstan is carried out by way

of the electricity and thermal energy markets, in which electricity and thermal energy are considered commodities. The markets operate as a series of

interconnected and co-existing markets: the balancing market, the auxiliary services market and the electricity market. The electricity market operates on both a

C:ER- the European Energy Handbook 2012

wholesale and retail level, whereas the thermal energy market is a single-level retail market.

On a wholesale level, the electricity market consists of:

•

•

a decentralised market functioning on the basis of sale-purchase agreements executed by market participants at prices and terms of supply determined by agreement amongst the participants;

a real -time balancing market aimed at regulating any hourly imbalances arising throughout the day between the actual and contractual amounts of

production and the consumption of electricity in the national power grid; and

• a centralised market comprising the organised trading floors for the sale of electricity on short-term (spot-trade), medium-term (weeks or months) and long-term (quarters or years) bases.

JSC Korem is the operator of the centralised electricity market, and is responsible for the

organisation of spot-trading and the regulation of centralised trading for the medium- and long-term. It is also charged with providing equal terms of access for wholesale market participants to the centralised trading market and providing them with information on indicative electricity prices obtained

from such trading .

Conditions for access to the centralised market include:

•

•

•

the filing of a statement of intent to participate in trade;

the provision of a copy of a contract between the company and a designated bank engaged in service trades ;

the registration of the participant on the market operator's system, including the completion of an application for registration and the provision of registration bidder cards in duplicate (the form of these documents is determined by the market operator); and

• compliance with trading rules.

Under Rule No 240 On Centralised Trading of

Electricity, dated 8 October 2001, on the wholesale balancing "day ahead" market a participant who has the right to purchase and/or sell electricity must notify the system operator before 11am Almaty time

on the day before the relevant day. This rule does not apply on weekends and holidays, and requests for trading on weekends or holidays must be filed before

11am on the working day before the first weekend or holiday date. Such requests can be submitted up to 7 days in advance.

Power generating companies are prohibited from

selling electricity to natural or legal persons who are not participants in either the wholesale or retail market, with the exception of sales for export purposes. Utility companies are prohibited from selling electricity to other

utility companies otherwise than on the balancing market.

221

A.3 Third party access regime

There are no special restrictions in respect of third party access to the national power grid, but all third parties must ensure compliance with the rufes on licensing and permissions. This will include the conclusion of a

contract with KEGOC as well as the agreement of a tariff with AREM.

A.4 Market entry (Supply and generation)

Full foreign participation (ie investments amounting

to 100% of the project value) is permitted in the

development of power projects in Kazakhstan.

As noted in paragraph A.1, projection and construction of standby power transmission lines and substations may only be performed with preliminary notification to and co-ordination with the Committee. Projection

and construction of power stations, power lines and substations and their operation may be performed on the basis of concession agreements. All such activities may be carried out only by licensed contractors or subcontractors.

Concession agreements are subject to a calculated

tariff which is to be agreed in the feasibility study for a given investment project. This calculated tariff may later be adjusted to become an individual tariff during

the implementation phase of a given project, as agreed withAREM.

A.S Public service obligations and smart metering

Power generating companies and network operators are subject to stringent controls by AREM, and must ensure that contracts concluded with KEGOC define the daily minimum amount of electricity to be generated, as well as the tariff applicable.

Smart metering does not exist in Kazakhstan. Power providers use home meters from which data is read and

recorded by an employee of the supplier.

A.6 Cross-border interconnectors

The national power grid is part of the unified power system of Commonwealth of Independent States ("CIS") countries, which involves the parallel operation of 11 CIS power systems as well as the power systems of the Baltic countries. KEGOC and the other national operators

are continually working towards the development of a

common electricity market in the Eurasian region.

KEGOC has stated that special emphasis is given to activities and proposals mooted within the framework of international organisations, including the Eurasian Economic Community (EurAsEC), Shanghai Cooperation

Organization (SCO), Single Economic Area (SEA) and

other communities and unions established for the purpose of mutually beneficial cooperation in the power sector.

On 19 November 2010 Kazakhstan, Russia and Belarus entered into a framework agreement on access to

monopoly services in the energy sector. The framework

222

covers, inter alia , principles of pricing and tariffing policy within the Single Economic Space of the Customs Union.

B. Gas

B.1 Industry structure

The oil and gas (O&G) sector remains the engine of

the Kazakh economy. The country is one of the top 20 oil producers in the world and production continues to increase. One of the major developments in the

' international O&G industry in recent years has been the

project of a gas pipeline between Central Asia and China.

According to Kazakhstan's Ministry of Oil and Gas (the "Ministry"), natural gas production in the Republic amounted to 37.4 billion cubic meters in 2010. The

Government plans by 2015 to export circa 30 billion cubic meters of natural gas annually to Russia and China through gas pipelines. Under the terms of an agreement on the counter-delivery of gas between Gazprom (a Russian state-controlled gas company), Uzbekneftegaz (an Uzbek state-controlled gas company) and KMG signed on 27 December 2006, all imported gas is exchanged at Karachaganak, one of three major Kazakh gas condensate fields, which in turn exports gas at the same price and in equal amounts.

The export of gas is subject to a rent tax, the rate of which ranges from 0% to 32% depending on market price, not including transportation costs or other deductions. In addition, export transactions must be registered with or notified to the National Bank of Kazakhstan.

The national supervisory and regulatory authority of the

gas sector is the Ministry, which was established in 2010 and is involved in the formation of public policy and in coordinating management processes in the O&G sector. It also has supervisory remit over the petrochemical

industries and the transportation of raw hydrocarbons. The Committee of State Inspection within the Ministry monitors the compliance of mining companies and the

execution by the same of subsoil contracts, including with regard to relevant local content requirements.

Key market players include KMG, KazMunaiGas Exploration Production JSC (KMG EP), KazTransGas

JSC (KTG) and private companies such as Karachaganak Venture.

KMG is the owner of 44 O&G onshore fields in the

Mangistau and Atyrau regions in Western Kazakhstan, and provides 65% of oil transportation, all gas transportation and 50% of tanker transportation carried out domestically within Kazakhstan. Transportation of

gas via pipeline is undertaken by KazTransGas JSC, with tanker transportation carried out by KazMorTransFiot JSC.

KMG EP was created in March 2004 following the merger

of JSC Uzenmunaigas (UMG) and JSC Embamunaigas (EMG), and is a subsidiary of KMG. The company's shares are listed on the Kazakhstan Stock Exchange

and its Global Depositary Receipts (GDRs) are listed

EER- the European Energy Handbook 2012

on the London Stock Exchange. In September 2006, the company raised approximately US$2 billion in its initial public offering, and is the second largest Kazakh oil-producer.

KTG, also a KMG subsidiary, provides gas production, transportation, marketing and trading services, including

the sale of gas and gas products. It operates the country's assets for the generation and distribution of heat and power energy. Currently, KTG owns the main gas pipeline system, the regional gas distribution

assets in six of the country's regions and shares in certain domestic power companies. At the same time, the company is developing its gas transmission base

and expanding its gas sales market share abroad by undertaking various projects !nternationally. KTG subsidiary KazTransGas LNG LLP oversees the treatment and processing of natural gas.

The Kazakh gas market is liberal and privatised. The largest private enterprise is the Karachaganak Venture (KPO BV consortium), which comprises BG Group

(32.5%), ENI (32.5%), Chevron (20%) and Lukoil (15%). Currently, ENI transmits up to 10% of its shares to KMG · through various mechanisms. In 1997, partners in the venture signed a Final Production Sharing Agreement (FPSA) which stipulated that the partnership would

operate Karachaganak until 2038.

The Ministry is currently working on a draft law On Gas and Gas Supply (the "draft Gas Law") , which contains provisions for the establishment of a state-owned national operator in the gas sector which will have the exclusive right to purchase gas from national gas extraction companies.

The main law currently in place regulating relations amongst gas market participants is the law No 291-IV On Subsoil and Subsoil Use, dated 24 June 2010 (the

"Subsoil Law"). It defines "oil" so as to include crude oi l, condensate, natural gas and associated gas and hydrocarbons that have been obtained after purification of either crude oil, natural gas or the processing of oil

shale or tar sands.

Under the Subsoil Law, subsoil use rights arise from :

• the direct provision by the State of a sub~oil use right upon conclusion of an exploration;

• extraction;

• joint exploration and extraction;

• agreements or a production sharing agreement (note: since 2009 PSAs are no longer recognised as a form of subsurface contract under the Subsurface Law);

• construction and/or maintenance of underground facilities not related to exploration and/or production

as the result of State tenders (note: there are some exceptions to this rule in which contracts can be concluded in course of direct negotiations);

• a transfer of rights of use by the previous

rights-holder disposing of shares in a legal entity who is a subsoil user to another entity; and/or

EER -the European Energy Handbook 2012

• a transfer of subsoil use rights by universal succession or in the event of the reorganisation of a legal entity who is a subsoil user.

An exploration contract may be granted for up to six years and subsequently may be extended twice for a period of up to two years each time. After a commercial

discovery is made, the subsoil user has the exclusive right to negotiate an extraction contract, which may in turn be granted for up to 25 years. For deposits with recoverable reserves of more than 100 billion cubic

meters of natural gas, an extraction contract may be granted for a period of up to 45 years .

·Almost all types of subsoil activities are carried out on the basis of temporary use in return for a fee.

It is a requirement of the Subsoil Law that subsoil model contracts contain certain obligations. This includes obligations and restrictions as to, inter alia: the hiring of

Kazakh personnel; the use of Kazakh goods, services

and works; implementation of social responsibility programmes; the commencement and rate of subsoil

operations; the amount of any subscription bonus; the size of investment; and compliance with health, safety and environmental requirements of domestic legislation.

Notably, the Subsoil Law introduced more stringent

legal requirements than had previously been in place

in respect of prohibitions on gas flaring, which proved controversial with existing subsoil users.

Activities subject to licensing by the Ministry include the design, engineering, exploration, extraction, transmission and storage of gas. In order to automate the licensing process and establish an effective mechanism for information exchange between state authorities and the business community, the Committee of State Inspection implemented the national "e-licensing" database4 . The

Licensing Law requires that licences shall be issued within 30 working days of an application being made. The main requirements are legal incorporation and compliance with certain qualifications (for example, availability of technical managers and specialists, certificates for construction or extraction works, proof of ownership or lease of the

industrial building, etc). The operation of a distribution

network and the storage of gas also require a licence from the Ministry, and many activities subsequently require appropriate environmental, sanitary, and other permits.

Given that the gas industry is dominated by state-backed

companies, the transportation of natural gas must comply with state-approved model agreements.

Gas export and import and other transactions involving international business deals are subject to transfer pricing legislation. The law On Transfer Pricing, dated 5 July 2008, stipulated that transfer prices are those which are agreed between related parties and differ from fair market prices. Transfer prices take into account the price range in arms-length transactions, ie, prices determined between independent and equal parties. Tax

and customs authorities exercise control by monitoring transactions, carrying out inspections and various other procedures stipulated by national laws.

223

If it is established in the course of an inspection that the transaction price deviates from the market price (taking into account any relevant price range), the competent authorities will accordingly make adjustments to the taxable and tax-related items.

8.2 Gas trading

The gas industry in Kazakhstan is, at the present time, still in the development stage. There is therefore no national operator or special trade platform, balancing market or specific legislation on gas trading, and parties may conclude financial and/or physical contracts on the

sale and purchase of gas on the commodity market. The Universal Commodity Exchange Astana, for example, is popular for trading liquefied gas (LNG).

Only brokers and dealers accredited on a given

commodity exchange may trade on it. The law On Commodity Exchanges, dated 4 May 2009, requires that a stock broker must be a legal person carrying out its

activities on the commodity exchange under a licence issued by the competent authority. The broker must exist in the legal form of a joint stock company or limited partnership, and conclude deals on behalf and at the expense of the customer.

8.3 Third party access regime to gas transportation networks

There is an open regime with respect to third party access to regulated services, goods and work in the gas sector and in respect of condensate gas storage and transportation through mains and/or distribution pipelines. Tariffs for gas pipelines are established by

the pipeline operator but must be approved by AREM.

Pipelines built and used by a private company exclusively for its own use are exempt from regulation by AREM , as is the CPC Pipeline (a cross-border pipeline) under special agreements between Russia and Kazakhstan.

KTG regulates the sale and purchase of natural gas and approves annual tariffs. Other pipeline operators

are obliged to follow a model agreement and the

corresponding rules on access.

8.4 LNG and gas storage

Until the draft Gas Law is fully drafted and in force, LNG facilities and gas storage fall under the common legal and

licensing regime of the Subsoil Law.

Gas storage contracts are based on model agreements

issued by the Government.

8.5 Market entry

As- mentioned in paragraph B.1 , the requirement for

entry into the gas market is the conclusion of a subsoil use contract with the Ministry of Oil and Gas, resulting

either from a successful tender or from the transfer of subsoil use rights or objects from an existing subsoil user. New entrants to the local energy market are not required to have a presence or a local subsidiary in order

to participate.

224

Under the Subsoil Law, the State has pre-emptive and

priority rights over gas deposits. In case of entry to the market though the purchase of shares in a subsoil use company or a gas deposit itself (ie a transfer of subsoil

rights), the State shall have a priority right to acquire subsoil use rights that are being alienated (or any part thereof). This right may be exercised through a national management holding company, a State-owned company or any other authorised state body. Thus, a person

intending to acquire rights or objects associated with gas fields must ensure that he has received appropriate state approval from the Ministry.

Until1999 the principal prerequisite to obtaining the right to enter into a subsoil agreement was a preliminary licence. However this procedure has since been abolished and, as noted, currently the legal basis for conducting subsoil activities is a contract between the Ministry and the subsoil user. Despite this change in

requirements, licences issued before the amendment are valid until their expiry date (as Kazakhstani law does not

have retrospective effect).

If the market entrance is conducted by way of a merger or acquisition that would lead to the creation of a natural monopoly or another type of economic concentration under Article 50.2 of the Competition LaW', the transaction will be subject to additional approvals by

AREM. The consent of AREM to conclude the aforesaid

transactions is required if:

• the total book value of the assets of the reorganized companies (group of persons), the acquirer (group of persons), or the target companies shares of which are being acquired, or if the total volume of sales for the last financial year exceeds 2,000,000 Monthly Calculated Indices or MCI6 at the date of application; or

• one of the persons participating in the transaction is a company holding a dominant or monopolistic position in the relevant goods market.

The conclusion of transactions without prior State consents

can lead to annulment of the relevant contract ab initio.

8.6 Public service obligations and smart metering

Gas utilities are natural monopolies and are therefore supervised by AREM, which also sets the tariffs for gas supply, transmission and storage.

Smart metering is not developed in Kazakhstan ; gas suppliers use home gas meters.

8.7 Cross-borper interconnectors

Gas pipelines in Kazakhstan , which functioned as an integral part of the USSR single-union system, mainly

serve the transit flows of natural gas from Central Asia to Ukraine, European Russia and the trans-Caucasian

states. A dearth of connections between the various main gas pipelines does not allow for the effective redistribution of gas between the various regions of the country. This is particularly the case for the Western,

Southern and Northern regions of the country, and is a

EER - the European Energy Handbook 2012

major impetus for the draft Gas Law, which provides for

a national operator that w ill also supervise the further development of the internal gas pipeline network.

On 15 July 2010, the P.rotocol on Amendments to the

Agreement between the Governments of Kazakhstan

and China on Co-operation in the Construction and

Operation of Gas Pipeline Kazakhstan- China (dated

18 August 2007) was signed relating to the second

phase of the construction of a gas pipeline flowing from Kazakhstan to China (the Beineu- Shymkent pipeline).

On 9 December 2010, Kazakhstan, Russia and Belarus signed an agreement on the rules of access to the

services of natural monopolies in the field of gas

transportation, including principles of pricing and tariff

policy within Single Economic Space.

c. Climate change and sustainability

C.2 Emission trading

The basic rules relating to emission trading are set out in the Ecological Code of Kazakhstan (the "Code") , dated

9 January 2007, which aims to reduce emissions into

the environment. Article 105 of the Code states that

the Government has the authority to introduce market

mechanisms establishing limits and quotas for emissions,

and to approve rules and obligations aimed at reducing emissions. In the case of establishing quotas, companies

shall be entitled to an annual quota of emissions.

The Code provides for the possibility of emissions

trading on an international level if relevant international treaties are ratified by Kazakhstan in the future. In such

a scenario, companies would be able to enter into

appropriate agreements with foreign individuals and legal entities in order to sell or to buy emissions.

Kazakhstan ratified the Kyoto Protocol to the United

Nations Framework Convention on Climate Change

on 26 March 2009. As such, the Government has

committed to attempting to implement emissions trading

mechanisms in relation to greenhouse gases, and to

provide incentives to reduce emissions within Kazakhstan.

Kazakhstan's domestic legislation obliges commercial premises to control the amount of carbon dioxide

("C02") emitted, and caps C0

2 emissions for certain

activities in the energy, metallurgy, mining, agriculture

and manufacturing sectors. Regulated companies must

obtain allowances for greenhouse gas emissions, which

are allocated by the Ministry of Environmental Protection

m major emitters, defined as those whose overall annual

emissions exceed 20,000 tons of C02.

C.3 Carbon capture and storage

There is currently no specific legislation on carbon

capture and storage in Kazakhstan. However,

commitment to the principle of the reduction of

emissions is set out in Article 310 of the Ecological Code.

=-=R- the European Energy Handbook 2012

As the main source of consumer energy in Kazakhstan is thermal coal-based power plants, the Government is currently working to develop and implement cleaner coal

technologies. In 2006 the EU and Kazakhstan signed a

Memorandum of Understanding on Collaboration in the

Sphere of Energy relating to clean coal technologies and

ecologically safe coal storage.

In June 2011 the first of a series of seminars relating to

carbon capture and storage, clean coal technologies, and the ecology, health, safety and economy of clean

technologies were held in Belgium and Germany. A pilot

project called ACCESS (Assistance in ecologically Clean

Coal and Environmentally Sound Storage), financed

by the EU, has begun in Kazakhstan. The Ministry

of Industry and New Technologies works together with local organisations to try to raise the profile of

Kazakhstan in the clean coal technology, carbon capture and storage spheres.

C.4 Renewable energy

The law On Support of the Use of Renewable Energy

Sources, dated 4 July 2009 (the "Renewables Law"), aims to define the main targets for and guidelines for the use of renewable energy sources ("RES") in Kazakhstan,

and thereby to encourage investment into the renewable

energy sector. The Renewables Law provides benefits for

companies dealing with RES, including companies which:

• utilise RES for construction or exploitation in the course of business;

• produce electric or thermal energy using RES; or

• provide preferential investments to individuals and

legal entities that utilise RES.

Regional network companies are required to purchase

electricity produced using RES in order to compensate

for the standard transmission losses in their networks,

up to a maximum of 50% of the size of such losses.

KEGOC has committed to purchase energy from RES companies that are fully connected to its grid.

Qualified RES generation companies can independently

set the selling price for their electricity, provided such a

price does not exceed a rate specified in the feasibility

study of the relevant RES construction project. Such companies are also exempt from payment to power

transmission organisations for the transfer of electricity or thermal energy.

At present, less than I% of energy consumption in

Kazakhstan stems from renewable sources, but it is

expected that RES consumption will surpass 1% by 2015

and will reach 5% by 2024. The development of RES is

also included as a goal in the Programme.

The following RES sources are currently used in

Kazakhstan: solar installations; wind energy installations;

hydroelectric plants; geothermal energy installations;

and installations utilising biomass, biogas and other

fuel of organic wastes for the generation of electric and

thermal energy.

225

Kazakhstan has five operational hydroelectric plants, which sit mostly on the lrtysh River. Other renewables

are largely undeveloped.

There is currently no "green" or "white" certificate trading

system in place in Kazakhstan . However, initial steps

were taken when the regulatory framework for such a system was developed in 2007 by the United Nations

Development Programme (UNDP) and the Government, in co-operation with the Renewable Energy and Energy

Efficiency Partnership and the Global Opportunities Fund. Under this framework, electricity producers would

be obliged to possess renewable energy certificates

to cover a certain share of their annual output. These certificates would be issued and initially sold by producers of 'green energy'. However, since the market for the trade of these certificates does not yet exist in Kazakhstan, the certificates would have to be purchased

by green energy providers from the Agency for Renewable Energy (which is yet to be created) for resale to electricity distributors.

C.5 Biofuel

On 15 November 2010, the President of Kazakhstan signed the law On State Regulation of Production and Turnover of Biofuel (the "Biofuel Law"). The law is aimed

at protecting the food security of the state, reducing emissions of pollutants into the atmosphere, and supporting research into and the application of scientific technologies in the production and turnover of biofuel. The law also introduced rules allowing the government of Kazakhstan to impose limits on volumes of biofuel

production facilities.

According to the Biofuel Law, biofuel production may be carried out if:

•

•

the biofuel producers are in possession of a production passport and metering devices that provide automatic transfer of information on the volume of biofuel to the authorised body; and

production takes place in a factory for the production of biofuel that belongs to the manufacturer on the

basis of a property right.

Accompanying invoices must be attached for the realisation, export and transportation of biofuel. Realisation may be carried out by persons engaged in biofuel production and/or those who are licensed in the compounding of petroleum products.

The storage of biofuel must be in premises belonging

to biofuel producers and producers of oil containing biofuel on the basis of a right of ownership or other proprietary right.

It is prohibited to use raw food materials in amounts

exceeding quotas set by the Government. This prohibition includes the use of grade 1 and 2 grain or

genetically modified materials during the production of biofuel, and manufacturers must not produce alcohol or dispose of non-denaturised ethanol , except for in the use of biofuel production. Additionally, there are restrictions

226

on the amount of biofuel that may be made by two or more producers at any given biofuel plant.

The Government and KazAgro (a national holdings company) regulate and supervise the industry. According to the Government Decree No 204, dated 1 March 2011,

the planned annual limit for the production of biofuel for 2011 is 2.8 billion litres, with a potential expansion to

3.2 billion litres by 2014.

In 2010 there was only one biofuel plant, Biohim, in

Kazakhstan, but the potential market is large due to the country's developed grain production capabilities.

Biohim produces bioethanol and biogasoline from feeder

grain and its residues. Furthermore, there are some micro and small private biofuel producers, many of which are members of the Kazakhstan Biofuel Association.

C.6 Energy efficiency

The Government has adopted several measures aimed at improving energy efficiency, including certain provisions of the Programme and the law On Energy Saving, dated 25 December 1997. These and other rules and proposals focus not only on efficiency per se, but also on the economic and organisational requirements that underpin efficient power generation and fuel usage. The overriding aim of these various measures is to

achieve greater environmental protection.

The Programme in particular includes several projects aimed at the modernisation of the existing power infrastructure parallel to the development of new

technologies, in particular renewables and biofuel.

D. Nuclear energy The law On Use of Atomic Energy, dated 14 April 1997, stipulates that activities associated with the use of atomic energy must be carried out under strict supervision by the state. The basic principles of state policy in the nuclear sector are designed to ensure safety, and include: the prohibition of radioactive waste

disposal by other states on Kazakhstani territory; the provision of social protection for nuclear facilities; and protections for those living and working in areas exposed to radioactivity. The law also aims to achieve transparency in relation to the discussion of public policy in the nuclear energy field.

Kazakhstan has been a member of the International Atomic Energy Agency (IAEA) since 1993.

The major state regulator of the sector is the Atomic Energy Committee ("AEC") of the Ministry of Industry and New Technologies. The AEC is the successor to the Agency on Atomic Energy, and is responsible for, inter alia, nuclear safety issues and the supervision of the nuclear sector. The AEC has control over all goods

exported and imported, as well as the provision of all

services, in the atomic energy field. This includes the transfer, sale or procurement of nuclear energy for commercial purposes or the transfer of the same for

EER - the European Energy Handbook 2012

non-commercial purpose. The AEC issues licences and transport permits for nuclear export- and import-related products under the terms of the law On Export Control, dated 21 July 2007. Nuclear materials, technologies,

equipment and stations are classed as nuclear export products, as are specified non-nuclear materials, equipment, dual use materials and technologies, radiation sources and isotope products.

Licences for nuclear import and export are granted only to those legal entities possessing the correct licences as

issued by the AEC. The granting of export licences and transit permits occurs only on the basis of a successful application completed in the prescribed form and after a comprehensive assessment of proposed export routes and end-user reliability. Certain categories of nuclear export require the assurance of an importing country (usually one not possessing nuclear weapons) that the obtained products are intended for peaceful use.

The AEC issues other types of licence based on The Licensing Law and Governmental Decrees No 1894 and 270, dated 29 December 1995 and 19 March 2008, respectively. A licence in this context is a document confirming that a legal entity is able to provide the safe use of the radiation sources, nuclear and other radioactive materials.

The relevant national operator is National Holding Kazatomprom ("NHK"), a subsidiary of NWF Samruk-Kazyna. NHK regulates the import and export of uranium, rare metals, nuclear fuel for power plants, special equipment and dual-purpose materials.

Kazakhstan currently has no nuclear power-generation capacity as the Aktau nuclear reactor, the country's only nuclear power plant, was shut down in June 1999. However, there are currently plans to build a new

1,500MW nuclear plant in near Lake Balkash in the South East of Kazakhstan.

footnotes

1. The Law of the Republic of Kazakhstan On The Electric Power dated 9 July 2004, No 588-11.

2. The Law of the Republic of Kazakhstan On Licensing dated 11 January 2007, No 214-111.

3. The Decree of the Government of the Republic of Kazakhstan On Approval of Model Agreements dated 10 March 2009, No 276.

4. http://elicense.kz

5. The Law of the Republic of Kazakhstan On Competition dated 25 December 2008, No 112-IV.

6. MCI is the minimum calculation index which is set by the Law on State budget annually. In 2011 it is 1,512 KZT.

:::ER - the European Energy Handbook 2012 227

Herbert Smith

For further information on any matters in this publication, please contact:

Albania Alexander Popp +43 1 534 37 478 a.popp@schoenherr.at

Krenar K. Loloci +355 4 225 0736 kl@lolocilaw.com

Austria Christian Schmelz +43 1 5343 7127 c.schmelz@schoenherr.at

Bernd Rajal +43 1 5343 7203 b.rajal@schoenherr.at

Belgium Wouter Geldhof +32 2 533 5259 wouter.geldhof@stibbe.com

Bosnia and Herzegovina Stevan Dimitrijevic +387 51 250 001 stevan.dimitrijevic@karanovic-nikolic.com

Bulgaria Stefana Tsekova +359 2 933 1073 s.tsekova@schoenherr.bg

Mariya Mihaleva +359 2 933 07 44 m.mihaleva@schoenherr.bg

Croatia Matthias Wahl +385 1 4576 492 m.wahl@schoenherr.at

Cyprus Marcos Georgiades +357 22 88 gooo mgeorgiades@cypruslaw.com.cy

Galatia Sazeidou +357 22 88 9000 gsazeidou@cypruslaw.com.cy

Czech Republic Martin Nedelka +420 225 996 500 m.nedelka@schoenherr.cz

Katei'ina Jandova +420 225 996 500 k.jandova@schoenherr.cz

Jitka Linhartova +420 225 996 500 j.linhartova@schoenherr.cz

Denmark Anders Stubbe Arndal +45 38 77 43 05 asa@kromannreumert.com

Lars M0ller Salling +45 38 77 43 73 lms@kromannreumert.com

Estonia Jaanus lkla +372 640 7170 jaanus.ikla@rln.ee

Finland Jyrki Prusila +358 20 506 6234 jyrki.prusila@roschier.com

llkka Puikkonen +358 20 506 6614 ilkka.puikkonen@roschier.com

France Mehdi Haroun +33 1 53 57 70 70 mehdi.haroun@herbertsmith.com

Ruxandra Lazar +33 1 53 57 70 70 ruxandra.lazar@herbertsmith.com

Germany Petra Linsmeier +49 89 21 667 220 petra.linsmeier@gleisslutz.com

Yvonne Kerth +49 711 8997 4628 yvonne.kerth@gleisslutz.com

Jan Hennig +49 30 800 979 108 jan.hennig@gleisslutz.com

Jan-Kristof Wellershoff +49 30 800 979 103 jan-kristof.wellershoff@gleisslutz.com

Greece Gus J. Papamichalopoulos +30 210 817 1500 g.papamichalopoulos@kgdi.gr

Hungary Janos Juhasz +36 1 345 8778 j.jahasz@schoenherr.hu

Tamas Balogh +36 1 345 8778 t.balogh@schoenherr.hu

Iceland Baldvin Bjorn Haraldsson +354 550 0500 baldvin@bbalegal.com

Ireland Alex Mclean +353 1 618 0546 alex.mclean@arthurcox.com

Claire Madden +353 1 618 0000 claire.madden@arthurcox.com

Italy Monica Colombera +39 02 89 63 071 mcolombera@legance.it

Federico Greco +39 02 89 63 071 fgreco@legance.it

Kazakhstan Yuliya Daurova +1 646 461 8105 yuliya.daurova@linkagemind.com

Latvia Girts Lejins +371 6724 0689 girts.lejins@rln.lv

Martins Aljens +371 6724 0689 martins.aljens@rln.lv

Lithuania Juozas Rimas + 370 5 250 0800 juozas.rimas@rln.lt

Ruslanas Cerniauskas +370 5 250 0800 ruslanas.cerniauskas@rln.lt

Luxembourg Dirk Leermakers +352 26 61 81 39 dirk.leermakers@stibbe.com

Former Yugoslav Republic of Macedonia Milos Vuckovic +389 2 322 3870 milos.vuckovic@karanovic-nikolic.com

Malta Roderick Zammit Pace +356 21 222 6088/6288 roderick.zammitpace@bar.com.mt

Montenegro Slaven Moravcevic +381 11 32 02 600 s.moravcevic@schoenherr.rs

Milos Lakovic +381 11 32 02 600 m.lakovic@schoenherr.rs

The Netherlands Martin In de Braekt +31 20 5460 242 martin.indebraekt@stibbe.com

Kirsten Berger +31 20 5460 479 kirsten.berger@stibbe.com

Norway Henrik Bj0rnebye +47 9 829 4553 henrik.bjornebye@adeb.no

Torkjel K. Gr0ndalen +47 9 829 4599 torkjel.grondalen@adeb.no

Karl Erik Navestad +47 9 829 4566 karl.navestad@adeb.no

Poland Jerzy Baehr +48 61 855 32 20 j.baehr@wkb.com.pl

Portugal Jose Luis Esquivel +351 21 384 5310 geral@esquiveladvogados.com

Romania Monica Cojocaru m.cojocaru@schoenherr.ro +40 21 319 67 90 Anca Velicu +40 21 319 67 90 a.velicu@schoenherr.ro

Russia Danila Logofet + 7 495 363 6500 danila.logofet@herbertsmith.com

Alexander Currie + 7 495 363 6500 alexander.currie@herbertsmith.com

Serbia Slaven Moravcevic +381 11 32 02 600 s.moravcevic@schoenherr.rs

Milos Lakovic +381 11 32 02 600 m.lakovic@schoenherr.rs

Slovakia Gudrun Stangl Lutz +421 2 571 007 01 g.stangllutz@schoenherr.eu

Michal Lucivjansky +421 2 571 007 01 m.lucivjansky@schoenherr.eu

Bernd Raja! +43 1 5343 7203 b.rajal@schoenherr.at

Slovenia Jani Sorsak +386 1 2000 939 j.sorsak@schoenherr.eu

Spain Miguel Riaiio +34 91 423 4000 miguel.riano@herbertsmith.com

Marta Sanchez-Villalta +34 91 423 4000 marta.sanchez-villalta@herbertsmith.com

Sweden Fredrik Wilkens +46 8 614 31 54 fredrik.wilkens@vinge.se

Christian Johansson +46 8 614 31 05 christian.johansson@vinge.se

Switzerland Mariella Orelli +41 43 222 1000 mariella.orelli@homburger.ch

Turkey Omit Herguner +90 212 310 1800 uherguner@herguner.av.tr

Ender Ozeke +90 212 310 1800 eozeke@herguner.av.tr

Kemal Mamak +90 212 310 1800 kmamak@herguner.av.tr

Ebru Onal +90 212 310 1800 eunal@herguner.av.tr

Ukraine Vladimir Sayenko +380 44 499 6000 vsayenko@sk.ua

United Kingdom Mark Newbery +44 20 7374 8000 mark.newbery@herbertsmith.com

Lynda Schlich +44 20 7374 8000 lynda.schlich@herbertsmith.com

European Union Silke Goldberg +33 1 53 57 70 70 silke.goldberg@herbertsmith.com

N ~

N 0 <0

~